Insight

Financial Reforms Open China to the Taiwanese

Jan. 16 marks the beginning of the next stage of engagement between Taiwan and China. That's when three long-awaited memoranda of understanding (MOU) come into effect liberalizing financial ties across the Taiwan Strait. The agreements, signed on Nov. 16 by Taiwan's Financial Supervisory Commission (FSC) Chairman Sean Chen and three counterpart agencies that oversee Beijing's banking, insurance, and securities sectors, allow financial institutions in both countries to set up liaison offices or upgrade such offices into branches.

But the MOUs are only the beginning. Compared with other countries, Taiwan is entering the China market late in the game, and the many hurdles set up by Chinese regulators for foreign players to enter their market have made it difficult for them to be competitive. That's one reason Taiwanese are now focusing on a proposed free-trade deal with the mainland called the Economic Cooperation Framework Agreement (ECFA), which will determine how each side will get preferential treatment beyond the WTO framework. In an interview, Chen speaks confidently of what Taiwan's government will achieve through its negotiations. "A level playing field is what we are going to achieve," he says.

Other foreign players have entered China with big aspirations, too, only to find themselves struggling to make their joint ventures or subsidiaries benefit from the country's growth. For instance, the Chinese insurance market is one of the fastest-growing in the world, expected to continue to grow 20% to 30% according to Research & Markets. Yet China's top three local players dominate the market; foreign players had only 4% last year, down from almost 6% in 2007.

Crowded China Market

Taiwan's finance sector certainly has advantages entering the mainland, since both sides share a language and a similar culture. Furthermore the ECFA would give Taiwanese financial institutions a leg up over other foreign competition. The question remains, though, how an island of 23 million people and a nominal GDP ranked 26th in the world can become a major player in a market that is catching all the attention from investors around the world.

Indeed, it would be almost impossible for Taiwanese players to be competitive without a better deal negotiated under the ECFA. According to Chinese rules, Taiwanese and other foreign securities firms can only enter the market with a joint venture with a maximum ownership of 33.3%; this joint venture can only do work in the brokerage business after five years of operations. Foreign banks cannot transact in the local currency for at least the first three years, during which they must have two consecutive years of profitability. "We intend to discuss with counterparties to eliminate this condition" during the ECFA negotiations, says Chen.

The situation is no better in insurance. The 5-3-2 rule ($5 billion in capital, 30 years in operation, and two years having a representative office in China) would rule out most Taiwanese players. For example, Fubon, the second-largest life insurer in Taiwan, has been in operation only 23 years. Foreign insurance companies cannot offer auto insurance, leaving them out of China, which last year passed the U.S. as the world's largest market for auto sales. And life insurers have to enter as a joint venture and can have a maximum stake of 50%. The joint-venture model has restricted foreign players from fully realizing their plans.

Negotiating Preferential Treatment

Chen's office says the government will address some of these problems, too. "We intend to negotiate more leniency on the 5-3-2 rule," says Bill Chang, the FSC's insurance commissioner. "There may be a way where the Taiwanese insurers can have up to a 50% stake but can sign up more than one Chinese partner who each, say, may have a 25% share. That way, Taiwanese insurers are able to have management control."

In the meantime, the new cross-strait agreement may not do much to attract outside investment in Taiwan's banking and insurance industry. The island's market is overcrowded, with more than 30 life insurers and 20 banks battling for business. Even if it were possible to view Taiwan as a gateway to China, most major foreign players are already in the Chinese market and may be better off focusing on the next round of WTO negotiations to gain more of a level playing field.

Taiwan's banks and insurance companies appear to have the basic ingredients to be competitive. However, a real breakthrough will only come with an ECFA. If such an agreement were to deliver on promises to Taiwanese financial institutions, the financial industry would get a glimpse of what it would be like to compete on a more level footing in China with local players.